Under Construction – January 2022 – Lexology

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Letter From the Editor
Welcome to this winter edition of our Under Construction newsletter. We hope your holidays brought you joy and that your 2022 is off to a wonderful start for you, your family, and your company.
In this newsletter, we explore various topics related to current construction trends and legal news that may be relevant to you and your business. The construction industry continues to ride its highs and lows, like many other industries operating through the COVID-19 pandemic. Whether it be delays and shortages due to the pandemic or recent court cases that are making an impact on the industry, we’ve covered a range of concepts in the below articles and convey what we think you should know.
We hope you will find these articles informative and enlightening. Please let us know if you want us to address a specific construction issue in a future newsletter. We hope you have a profitable, busy, healthy, and safe 2022!
Colorado Enforces Ambiguous Limitation of Liability Clauses
On September 23, 2021, the Colorado Court of Appeals issued its opinion in Johnson Nathan Strohe, P.C. v. MEP Engineering, Inc., addressing a matter of first impression. The court of appeals held for the first time that an ambiguous limitation of liability clause may be enforced. This stands in contrast to ambiguous exculpatory agreements, which have long been deemed unenforceable in Colorado.
Johnson Nathan Strohe, P.C. v. MEP Engineering, Inc. involves the design and construction of a Denver apartment building. The project owner hired the plaintiff-architect to design the apartment building. In turn, the architect hired the defendant-engineer to provide mechanical, plumbing, and electrical design services, including the design and implementation of a heating and hot water system. The architect and engineer’s contract included a limitation of liability provision stating:
Limitation of Liability: In light of the limited ability of the Engineer to affect the Project, the risks inherent in the Project, and of the disparity between the Engineer's fees and the potential liability exposure for problems or alleged problems with the Project, the Client agrees that if the Engineer should be found liable for loss or damage due to a failure on the part of MEP-ENGINEERING, INC. such liability shall be limited to the sum of two thousand dollars ($2,000 or twice The Engineer's fee whichever is greater) as consequential damages and not as penalty, and that is liability exclusive.
Later, significant issues arose concerning the heating and hot water system. The building owner filed an arbitration demand against the architect, and a $1.2 million damages award was entered against the architect. The engineer was not a party to the arbitration.
The Lawsuit
Thereafter, the architect sued the engineer seeking to recoup the amount for which it was found liable in the arbitration. In turn, the engineer filed a motion for a legal determination of the enforceability of the limitation of liability provision in its contract. The architect argued, in part, that the provision was ambiguous and thus unenforceable. The district court disagreed and dismissed the case after the engineer deposited $252,720 (twice its fee plus interest) into the court’s registry.
The architect appealed, arguing that the district court erred in finding the limitation of liability provision unambiguous. The court of appeals agreed, holding that the limitation of liability provision was ambiguous. The court of appeals focused in on the provision’s application to “consequential damages” and whether the provision thus applied only to consequential damages but not other forms of damages.
Notwithstanding, the court of appeals went on to hold that “a limitation of liability in a commercial contract is not void merely because it is ambiguous. Like other ambiguous contract provisions, the meaning is a question of fact that courts must determine using ordinary methods of contract interpretation.” In so holding, the court of appeals decided that limitation of liability provisions should be treated like run-of-the-mill contract provisions and not like exculpatory provisions, which are void and unenforceable if ambiguous. The court of appeals explained that while limitations of liability and exculpatory provisions both reduce liability, “they are different in kind.” Exculpatory agreements bar liability entirely whereas a limitation of liability provision still renders a party liable but at a “bargained-for level.” The court of appeals remanded to the district court to determine the meaning of the limitation of liability of clause.
Johnson Nathan Strohe, P.C. v. MEP Engineering, Inc. is reflective of Colorado’s permissive approach towards parties’ ability to limit (but not escape) liability. The case is a clear signal that parties involved in commercial construction cases should take extreme care when negotiating limitation of liability provisions in their contracts as those provisions are likely to be enforced.
Shortages and the Arizona Purchaser Dwelling Action Act
The Arizona Purchaser Dwelling Actions Act (“PDA”) provides construction professionals with an opportunity to remedy an alleged defect before a homeowner may file a lawsuit. When faced with an alleged defect, a construction professional may attempt to avoid litigation by electing to repair or replace the alleged defect or provide monetary compensation to the homeowner. However, labor and material shortages, including those caused by the COVID-19 Pandemic, have made deciding how to use the PDA’s options more difficult.
Before a homeowner may file a lawsuit against a construction professional for a construction defect, the PDA requires that the homeowner give the professional detailed notice about the allege defect. A professional then has 60 days to respond as to whether the professional will repair or replace the alleged defect, provide alternative compensation, or decline to take any action. If a professional agrees to repair an alleged defect, the PDA requires a repair be completed within a “commercially reasonable time frame considering the nature of the repair or replacement, any access issues or unforeseen events that are not caused by the . . . professional.” (emphasis added) Current labor and material shortages probably affects what constitutes “commercially reasonable.” Additionally, the “foreseeability” of labor and material shortages is likely to become an even more contentious topic. Therefore, if using the PDA’s options to repair, professionals should consider documenting any labor or material shortage delays and their causes as they become known to be better prepared if a homeowner alleges that the professional failed to comply with the PDA.
In addition, if a professional foresees a repair or replacement taking longer than normal, the PDA does afford some options. The PDA allows a professional and homeowner to enter into a written agreement to extend the timeframe to comply with the PDA. When a professional expects or anticipates that a repair may take longer than “normal” the professional should consider extending the timeframe for repairs with the homeowner in writing before beginning repairs. On the other hand, if a professional’s failure to comply with the PDA’s timeframe results from an unforeseen condition, a homeowner may be required to give the professional more time to make the repair before filing a lawsuit.
If a professional opts to offer monetary compensation instead of repairing or replacing the alleged defect, a new issue arises: should the offer be for the amount it would have cost to repair or replace the defect when the work was first done (i.e. before material and labor prices increased) or the current prices? The difference in these costs is even more pronounced when the original construction was completed years ago for a fraction of what it would cost to perform repairs in today’s market. For example, Arizona’s statute of limitation for breach of contract allows a homeowner to bring an action for breach of construction contract for six years after the cause of action accrues. Therefore, it is possible a homeowner may seek to hold a professional liable for an alleged defective construction that occurred years ago.
The PDA does not provide guidance as to what offer amount is appropriate, particularly because a homeowner may reject any offer and instead sue to attempt to recover the current cost of repairing the alleged defect. Furthermore, a professional should consider giving an offer amount serious thought. An amount offered has consequences even if rejected by the homeowner. In a subsequent lawsuit, a professional could potentially be liable for the homeowner’s attorneys’ fees if the homeowner recovers more than the professional originally offered. Therefore, careful consideration is due before making an offer.
Utah Courts Expand the Reach of the Economic Loss Rule in Construction Disputes
Utah courts continue to strengthen both the common law and statutory economic loss rule by limiting what duties are independent of those in a typical buyer/seller contractual relationship and thus limiting the common law exception for the economic loss rule.
Under the common law economic loss rule, a party suffering only economic loss from the breach of an express or implied contractual duty may not assert a tort claim for a breach of the same duty. Nevertheless, courts have recognized an exception to the general rule: "When an independent duty exists, the economic loss rule does not bar a tort claim because the claim is based on a recognized independent duty of care and thus does not full within the scope of the rule.” Hermansen v. Tasulis, 2002 UT 52, ¶ 17, 48 P.3d 235. The Utah legislature codified the economic loss rule, and with respect to actions “for defective design or construction,” those claims are limited to breach of contract claims “by a person in privity of contract with the original contractor, architect, engineer, or the real estate developer.” Utah Code Ann. § 78B-4-513(1), (4). Two recent Utah court opinions further clarified the boundaries for both the common law exception to the economic loss rule, and the statutory rule’s limits for defective design claims.
First, the Utah Court of Appeals in Throp v. Charlwood found that a homeowner’s tort-based claims against the previous owner were based on duties that completely overlapped with the duties arising from the contract, and therefore the exception did not apply. 2021 UT App 118. Charlwood purchased a house in 2005 that was built in 1991, completely remodeled and expanded the house, and sold it to Throp in 2007. The parties’ Real Estate Purchase Agreement (“REPC”) expressly incorporated the Seller Property Condition Disclosure Form, but indicated that Throp’s “obligation to purchase under [the] Contract … IS NOT conditioned upon [his] approval of the content of all the Seller[‘s] Disclosures.” Ten years after Throp took possession of the property, he discovered that the deck was constructed in a defective manner, and other latent problems with the property. Throp sued Charlwood, asserting claims for defective construction, negligent misrepresentation, and fraudulent misrepresentation. The district court granted Charlwood’s motion to dismiss, holding that the economic loss rule barred Throp’s claims.
On appeal, Throp argued that his misrepresentation claims should survive because they arose from two duties Charlwood owed Throp, both of which are independent of those in the REPC: 1) the duty of sellers of real property owners to disclose material known defects that cannot be discovered by reasonable inspection of an ordinary prudent buyer; and 2) the duty of developer-and contractor-sellers to disclose information known to them concerning real property when the information is material to the condition of the property. The Court of Appeals disagreed, holding that the duty of sellers is not independent of the duties provided in the REPC because the REPC expressly incorporated the Seller’s Disclosures, and therefore the duty of sellers completely overlapped the duties in the REPC. The Court further found that Charlwood was not a developer- or contractor-seller merely because he completely remodeled the home, and therefore did not owe Throp such a duty. Because his tort-based claims were not based on duties independent of those in the REPC, the economic loss rule barred Throp’s misrepresentation claims.
Second, the Utah Supreme Court in Hayes v. Intermountain GeoEnvironmental Services, Inc. held that a homeowner's negligence claim against a geotechnical engineering firm that provided a geotechnical report for the property was essentially an action for defective design, which is limited by the economic loss statute to those in contractual privity with the firm and no common law exception was available. 2021 UT 62. Shortly after moving into their new home, the Hayes noticed the walls and foundation cracking and later found that it was caused by failures in the soil about 65 feet beneath their home. The Hayes sued Intermountain GeoEnvironmental Services, Inc. (“IGES”), who contracted with the Hayes’ builder to provide the geotechnical report for the project. The Hayes alleged that IGES, who collected boring samples up to only 50 feet below the surface for its report, negligently concluded that the soil was safe for the project. IGES moved to dismiss, arguing that the economic loss rule barred the Hayes’ claims, which the district court granted and the Utah Court of Appeals affirmed on appeal.
On appeal to the Utah Supreme Court, the Hayes argued that their claim did not fall under the statutory economic loss rule for defective design because IGES did not engage in “design or construction.” Utah Code Ann. § 78B-4-513(1). The Supreme Court disagreed, and its analysis turned on the definition of “design.” The Court found that the legislature’s intended definition of “design” included geotechnical engineers because a geotechnical report is a necessary component of the structural design of the home, is therefore integral to the design of the project itself, and is therefore subject to the economic loss statute. Hayes further argued that the Court of Appeals erred by not considering whether IGES owed them an independent duty. The Supreme Court again disagreed, finding that because Hayes’ claims were essentially for defective design, the economic loss statute controlled, and therefore no common law exception was available to them. The Supreme Court noted that in the area of design and construction, the “legislature requires parties to protect their financial interest through contracts. Beyond that, we are not at liberty to graft into the statute an exception that our legislature chose not to include.” Hayes, 2021 UT 61, ¶ 37. Because no independent duty exception is included in the economic loss statute, the Court declined to analyze a possible independent duty IGES may have owed Hayes and affirmed the lower court’s ruling.
Cost Escalation – Are You Ready? Contract Tune Up for 2022
Looming large on the 2022 construction landscape horizon is the specter of cost escalation claims. Over the past year, rising prices have become extreme, and the clauses governing cost escalation have come under greater scrutiny as the construction industry struggles with a series of impacts coalescing around challenges to cost predictability and stability. The emergence of Covid 19 in early 2020 is still with us. This has led to worldwide shutdowns, supply chains interruptions, material shortages, labor shortages, changing safety requirements and a rate of inflation of the likes of which has not been seen in the past 40+ years.
Construction industry players, including the owner, design, and construction management side, may want to spend time reading and reviewing their standard contracts with the view towards analyzing language addressing cost impacts and price escalation. The challenges will be with us throughout 2022. It is of vital importance that your contracts address cost escalation considerations; and, if your existing contracts do not address such considerations, you may want to address this issue forthwith by revising existing contracts.
The three most common types of cost escalation clauses are (1) any-increase escalation, (2) threshold escalation, and (3) delay escalation. An any-increase escalation claim entitles the contractor or supplier to reimbursement for the price increases that occurs after the execution of the contract. This type of clause typically attaches to specific types of materials and equipment which will likely have a benchmark and allowance associated with the specific material.
A threshold escalation clause allows for an increase in material cost up to a certain amount or threshold, whatever the parties agree upon which is usually a certain percentage. In the case of public works, a threshold escalation clause may be standard, set by the federal, state, or local government. In private works, it is what the parties typically negotiate.
The delay escalation clause entitles the contractor, or provider of services, to claim and recover for increased costs due to the delay in the project progress beyond a predetermined date or dates of work.
Importantly, without an express price escalation clause in your agreement or contractual right to recover increase costs grounded in law or governmental regulation, the contractor or service provider harmed by pricing increases will face a steep and difficult battle trying to recover increased costs on a fixed price contract. Furthermore, escalation clauses usually never allow a contractor to recover costs resulting from under bidding a job if the contractor chooses to not rely on information relevant to the bid preparation. Thus, a contractor or service provider may want to routinely thoroughly back up and support its bid or proposal price.
Best practices may include a bid sheet which estimates the price of the job down to the labor and material required. This bid sheet may then be supplemented with actual material invoices or quotes received for labor materials listed on the bid sheet or subcontractor quotations including those identified in change orders. You may want to obtain multiple quotations. The contractor may want to document proof of payment for purchased material and labor to demonstrate that it was paid for at the prices invoiced or quoted. Transparency is usually your best option, so you may want to document carefully and thoroughly. Generally, the more transparent you are in providing documentation, the more persuasive your claim.
A contractor may want to be more proactive to avoid, or at least mitigate, any costs escalation in the current construction environment. Such proactive steps may include providing notice as soon as the project manager learns of longer than usual lead time for materials, or a significant increase. The contractor project manager usually should also promptly request a substitution, if possible. Document the process and submit change order requests for price increases. Included in this documentation should be the price on which the bid was based to establish the delta in cost. Comply with your claim notice requirements.
You may want to be proactive and review your time extension, cost escalation, and force majeure extension clauses now. There’s usually no advantage to waiting until a problem arises to understand what your options are. It is still too recent in the current era of COVID-19 to expect much in the way of relevant legal cases to guide your analysis and decision making so there is a greater element of unpredictability of who bears the risk. If the specifications include a clause that provides for change orders when there is a “change in the character” of the work, this type of generic language may provide a good argument for justifying additional payment. Certainly, many of the supply chain issues have completely altered the nature and character of the work in terms of acquiring materials and equipment.
There may be other possible avenues for recovery of extreme cost increase including a cause of action for breach of the covenant of good faith and fair dealing implied in all contracts. This theory will not relieve a party from performing contractual obligations because the contract is no longer profitable; however, it may prevent parties from acting in bad faith in dealing with these cost escalation problems.
Two other legal theories which may be useful to potential avenues of recovery include commercial impracticability and frustration of purpose. With commercial impracticability, a contract is commercially impracticable because performance would cause extreme and unreasonable difficulty, expense, injury, or loss to one of the parties. This is usually a difficult burden to prove. Just because it may cost a lot more to do the work does not mean the doctrine of commercial impracticability will apply. Similarly, there is the doctrine of frustration of purpose of contract. This legal theory allows the court to excuse an obligation to perform under the contract if the contractor can no longer achieve its purpose for the transaction and the contractor did not cause the frustration of performance. Basically, the frustration must be so severe that completing the transaction makes little sense. In either case, commercial impracticability, or frustration of purpose, you may be able to recover the cost incurred in attempting to perform the contract. However, these generally are difficult legal theories to prevail upon and there is no guarantee of recovery. They also typically only apply to cases of extreme or monumental cost increases.
Be proactive. You may want to review your contracts now and take the time to learn and understand both the content and application of any potential cost increase recovery mechanisms in your agreements. Going forward, you may want to confirm that any new contract you are about to enter addresses cost escalation. The threat of extreme cost escalation disruption may be with us for some time so you may want to get prepared now.
When Is a Project Delay Material and Actionable?
Welcome to 2022! This year, the construction industry will undoubtedly reflect on the last two years as unprecedented times plagued by construction project delays. The COVID-19 pandemic contributed to suspension of work and closure of construction projects worldwide in 2020. The end of 2021 brought additional delays caused by an inexplicable clog in the supply chain of construction materials. The combined impact of these events on project milestones and completion deadlines led many to ask, with unusual and particular urgency, who is liable for such delays and how do contracting parties lessen the consequences from such unexpected and uncontrollable delays.
Granted that project delays are nothing new or unusual. They were common enough before inflation caused shipping complications and pandemic decimated the construction labor force. All delays, whatever the source, variably cause loss to all players on a construction project. But not all delays matter when it comes to claims and remedies available to the contracting parties in dispute resolution, where the determinative focus is on material delays impacting the entire project and on delays the claimant can credibly prove.
Most, if not all, jurisdictions interpret actionable delays from the contract documents for the project. The contract is definitely where you should start before pursuing any delay remedies. Delay remedies may be a time extension only, or a time extension plus your additional general conditions. Some delay remedies may be barred by the contract’s express terms and may be enforced adversely by the courts when such contract terms are indisputable. See Quinn Constr. v. Skanska USA Bldg., Inc., 730 F. Supp. 2d 401, 411 (D.C. Pa. 2010) (enforcing the subcontractor’s contractual waiver of claims for delay and disruption damages). On the other hand, delay damages that are expressly allowed by the contract—like overtime necessitated by the delays—are usually actionable and recoverable. Id. However, not only the contract terms, but applicable law, may affect the outcome.
As an example, other delay remedies may not be expressly allowed by the contract but may be recoverable if they were sustained on the critical path of the project schedule and were not caused by the claimant themselves. The term “critical path” is familiar enough as an industry term but is often mistaken as a determinative legal principle. Consider this clarification of critical path in Quinn:
“Critical path” is a term of art, not a legal concept; a project’s critical path is simply a collection of those construction tasks that cannot be delayed without delaying the entire project. 730 F. Supp. 2d at 407 (citing 5 PHILIP L. BRUNER & PATRICK J. O’CONNOR, JR., BRUNER & O’CONNOR ON CONSTRUCTION LAW § 15:120 (West) (case citations omitted). … While [Critical Path Methodology] has generated a technical terminology, the legal requirement that it is used to analyze is general and commonsensical: a contractor must prove that a delay affected not just an isolated part of a project, but its overall completion. 730 F. Supp. 2d at 408; see also Cortinas Painting & Rest., Inc. v. Corp Inc., Constr., 2017 WL 4640326 *7 (Wash. App. 2017) (“[c]ritical path methodology analyzes the legal requirement that a delay affects overall completion of a project.”) (citing Morrison Knudsen Corp. v. Fireman’s Fund Ins. Co., 175 F.3d 1221, 1233 (10th Cir. 1999)).
Thus, it is important to distinguish your burden of proving a material and compensable delay from the critical path methodology. Critical path methodology is one means of proving that the delay is actionable, ideally with reliable expert testimony and contemporaneous evidence showing impact on the overall project schedule completion date.
Causation, on the other hand, is a key legal element that must be proven along with facts establishing delays on the critical path. A compensable delay is usually a delay caused by someone else on the project, so a contractor cannot cause its own critical path delays and credibly prove it is entitled to delay damages. If the contractor, for example, was carelessly late in ordering its materials, the contractor will have a much harder time proving that supply chain complications were to blame for blown completion dates on the critical path. In addition, a project owner that fails to implement or require a safety protocol for protection of all project personnel from the coronavirus cannot usually credibly prove it was really the contractors who caused an outbreak and indefinitely shut down the project.
These commonsense principles governing delay claims equally depend upon comprehensive and timely documentation of the delay. Written correspondence confirming delay causes and consequences should be contemporaneous and immediate. Delay documentation should also be sufficiently detailed and timely to put key players on notice that the delay will impact the critical path, further citing specific contractual provisions that trigger available remedies for the delays. Conversely, after-the-fact and imprecise documentation of the delay carries little weight with judges, juries, and arbitrators and tends to suggest that the delay is neither material nor actionable. Proving a material and actionable delay, therefore, usually requires favorable contractual terms, critical path impact, favorable law, and believable documentation demonstrating timely notice and no fault for the delay.
The Washington Supreme Court Renders a Significant Decision on Application of the Spearin Doctrine for Washington Projects
In September 2021, the Washington Supreme Court issued its decision in Lake Hills Investments, LLC v. Rushforth Construction Co., Inc., 198 Wash.2d 209 (2021). This case is significant because it establishes a comparative fault rule that applies when construction defects result from a combination of flaws in the design provided by the owner’s consultants and deficiencies in the performance by the contractor.
Lake Hills Investments (Lake Hills) retained AP Rushforth (AP) as the contractor to construct a mixed-use project. A dispute arose during the project. Lake Hills filed a lawsuit against AP for breach of contract, alleging that AP’s performance was delayed and defective. AP filed a counterclaim alleging that Lake Hills underpaid AP. Also, AP asserted an affirmative defense under the Spearin doctrine, alleging that the alleged performance issues resulted from Lake Hills providing a defective design concept, rather than viable plans and specifications.
The Spearin doctrine asserted by AP stems from the U.S. Supreme Court’s decision in United States v. Spearin, 248 U.S. 132 (1918). In Spearin, the Court confirmed that a project owner impliedly warrants the adequacy of the plans and specifications to the contractor. The U.S. Supreme Court held that “if the contractor is bound to build according to plans and specifications prepared by the owner, the contractor will not be responsible for the consequences of defects in the plans and specifications.”
At the Lake Hills trial, the court gave the following jury instruction concerning AP’s Spearin doctrine affirmative defense: “AP has the burden to prove that Lake Hills provided the plans and specifications for an area of work at issue, that AP followed those plans and specifications, and that the [construction] defect resulted from defects in the plans or specifications. If you find from your consideration of all the evidence that this affirmative defense has been proved for a particular area, then your verdict should be for AP as to that area.”
The jury found that AP had performed defective work, but that Lake Hills had also breached the contract. The jury rendered a net verdict of $9.2 Million in favor of AP, including $5.8 Million in attorney fees and costs. Lake Hills appealed, focusing on the above quoted jury instruction. On appeal, the Court of Appeals concluded that the jury instruction was prejudicial to Lake Hills. The Court of Appeals determined that, in order to benefit from the Spearin doctrine, the law required AP to prove that construction defects were “solely” caused by defective or insufficient plans. As a result, the Court of Appeals determined that the jury instruction was misleading and prejudicial to Lake Hills.
On review, the Washington Supreme Court reversed the Court of Appeals’ decision. The Supreme Court ruled that the Spearin doctrine does not require an all or nothing result for either the owner or the contractor. Rather, it comes down to a matter of fairness based on control. “An affirmative design defect defense is a complete defense if the damage is solely due to the design. However, if the defects were caused by a combination of deficient performance and deficient design, then it is not a complete defense.” Lake Hills, supra.
In other words, the Court held that when a contractor alleges a Spearin doctrine defense in a construction dispute involving a combination of deficient design and deficient performance, the court should apply a comparative fault type of standard. This is significant because contractors in Washington now do not have the burden of proving that defects were “solely” caused by ineffective designs, and owners do not have to risk losing their entire claim if a jury wants to hold the owner responsible for a defective design. The Court’s decision allows a middle ground standard that cuts both ways for the owner and contractor.
Other states may follow the Lake Hills decision’s application of the Spearin doctrine.
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